Tuesday, November 18, 2008

Why Thomas Friedman Is Stupid

Here’s our Bronx-summary of the past few years’ worth of what Thomas Friedman has had to say about the domestic automakers: You’re stupid Detroit, yeah all of youse in Michigan too! Ya bums been making crap product forever and pay off DC’s lobbyists to get your way! You guys support terrorists! Shame on you! And you car guys - dumb! Get out of here, all of ya! SUVs, trucks, they all make me wanna puke! Ya should be making hybrids damn it! Below are a few quotes from Friedman OP Ed pieces published on the NY Times website: “Is there a company more dangerous to American’s future than General Motors?” “How can these companies be bad for so long? Clearly a combination of a very un-innovative business culture, visionless management, and overly generous labor contracts.” “In return for any direct government aid … the board and management [of GM] should go … someone hard nosed and non-political should have broad power to revamp GM … this will mean tearing up existing contracts with unions, dealers, and suppliers … must demonstrate a plan for transforming every vehicle in its fleet to a hybrid-electric engine with flex-fuel capability … somebody ought to call Steve Jobs who doesn’t need to be bribed to do innovation.”

Philip Pullman wrote the book, “The Golden Compass.” It is one book in a fantasy trilogy about parallel worlds that one can move in and out of through windows. Each world is subtly different from the others. It’s a sure bet that Thomas Friedman was a source of inspiration for Pullman. Friedman came from another world where Clive Cussler got a Nobel Prize for literature, American Pie II got an Oscar for best picture, and Tommy-boy got his Pulitzer. Again, from the internet (Dictionary.com), Stupid means: lacking ordinary quickness and keenness of mind; characterized by or proceeding from mental dullness; foolish; tediously dull, esp. due to lack of meaning or sense; inane; pointless: a stupid party; annoying or irritating; troublesome. Most children are told not to use the word “stupid”. Instead, we are urged to use the word “ignorant.” You should reserve the word “stupid” only for the profoundly ignorant. Friedman is profoundly stupid. Too bad he has a lot of influence. We hear a lot of television commentators chirping Friedman songs that have no relationship to the facts. Rather than spend a couple of hours studying a little history, Friedman is one of those “smart” stupid people, like Karl Rove, who would rather focus their intellectual powers on defending their non-fact-based view of the world.

In a nutshell, Friedman thinks: (1) the domestic automotive executives are without talent, (2) that they should only be making hybrids, (3) that there is vacuum of innovation in Motown, and (4) that they’ve been ”bad for so long.” His stupidity, therefore, has at least four dimensions. The first three are easy to prove wrong; however, most of this blog is focused on history.

Tommy, if you really are as smart as you think, how well would you do in strategically managing a car company’s fixed costs that are governed by a plus-thousand page labor relations rule book? How do you sing proud of your liberal politics with one voice and fix, with another voice, those “dinosaur companies” you deplore by hacking away at wage rates, health benefits, and working conditions? If you are really this smart, go get a job with Barack and help him fix the carnage that the folks a bit downtown from you wrought.

First, let’s talk about talent. Ford is run by Alan Mulally, a 37 year veteran of Boeing. This guy is a ringer if ever we saw one – he is turning Ford around, albeit, somewhat painfully. American Honda is a breathtakingly brilliant company whose top American executives are Dick Colliver (ex-Chrysler) and John Mendel (ex-Ford.) GM’s Bob Lutz is the guy who saved Chrysler the second time around, and we have never met anyone who is not awed by his passion and intellect. We suspect Lutz feels the same way about Rick Wagoner – Rick and Chrysler’s Jim Press are just about the two smartest people we have ever met. Renault’s management prodigy, Carlos Ghosn, runs Nissan worldwide; Renault exited the very tough US market in the late 1980s (remember the LeCar) and still has not come back. Chrysler is run by Bob Nardelli, the no-retail-experience ex-GE guy who saved, and grew, Home Depot using Six-Sigma. He doubled sales and doubled profits there. His second in command is a true genius, Jim Press, who used to run Lexus and Toyota Motor Sales – he’s no slouch. Chrysler did what Tommy suggests for GM; Chrysler retired their leadership, brought in the best talent in the world, and nuked their board of directors. So, given Chrysler’s struggles, world class talent and oversight probably is not the silver bullet here. Every player in this industry has a wealth of talent at the top – simply changing them out is not the answer. You are wrong Tom.

Ok, now to hybrids. Tommy, look about 12 inches down in this blog and you will see a Wall Street Journal web-chart that shows motor vehicle sales through October, 2008. You will see that Toyota Prius sales are down this year by 5.3% and were down 10.3% in October. Ford Focus sales were up 20.5% in the first 10 months of 2008, and the Focus outsells the Prius. Hmmm. Maybe the market is telling us that hybrids are not the complete answer? Maybe car companies do not have a social responsibility to cram products down the throats of customers that they do not want? Maybe. Tommy, you are dumber than a door nail on this one.

Innovation. Tom-boy uses Steve Job’s name as an incantation to show what he means by innovation. Let’s focus on just one example: GM’s OnStar telematics capability. GM has the highest telematics install base of any OEM in the world. Ford, working with Microsoft, (sorry, Mr. Jobs, we know how you feel about those guys) recently introduced a competing product called “Sync.” Sync is at least 5 years behind OnStar. What does OnStar do? It tells you if anything is wrong with your vehicle. It sends you an email telling you if your tire pressure is OK (tire pressure was linked to certain vehicle roll-over problems). It is linked to MapQuest, so you can download a trip plan from your PC to your car. It calls an ambulance if you crash. It tells you how to get out of the path of a hurricane. It responsibly stops your vehicle if it is stolen, and it can open the doors if you lock yourself out. It is a world class nexus of innovation and social responsibility. If Tommy can’t call this world class “innovation”, then we’d call this prima facie evidence of his stupidity.

History. Rather than simply compile a list of Friedman “historical” stupidities, let’s first lay the simple foundation of how the US automobile industry has evolved over the past 83 years.

Three important early years to remember: 1935, 1937, and 1947. The 1935 National Labor Relations Act (NLRA) created closed shops, where a condition of employment could be forced membership in a union. Back in May 26, 1937 pictures were taken of Ford enforcers beating UAW official, Richard Frankensteen (believe us, this is the correct spelling), in the Battle of the Overpass. Beating labor organizers was a very bad idea. In 1947, the Taft Hartley (Right to Work) Act undid NLRA if states so chose to do so. Twenty two states are now Right to Work states. The states that are not Right to Work generally are the ones that have/had a significant portion of their employment in labor unions – automotive and other. Tommy, pay attention here this is important. The UAW became the most powerful labor union in the world over the course of 83 years. Besides grizzly pictures of getting beaten up, they have leverage. The UAW continually refined their labor contracts with each of the domestic automakers through pattern bargaining, where the current national agreement “rule book” is longer than James Cavell’s Shogun. Compare this to the rules of chess in Wikipedia – chess rules contain 3,993 words and prints to 13 pages including loads of graphics. Years ago the domestics incrementally, in pattern formation, negotiated away their ability to reinvent themselves in non-Right to Work states. And, with that, the door was opened for serious competition.

From 1947 to October 15, 1973 all this labor legislation really didn’t matter much. Gas was cheap. We all loved what the domestics served up, and many still are fans of the fins of the 50’s and flames of the 60’s. Volkswagen was the big importer of record, but not a threat to the Big-3.
They served a small niche market (of about a half million units) of folks who wanted small fuel efficient cars. The “big” (actually, it was quite little) threat VW represented in 1963 was in pickup trucks. West Germany tripled their tariffs on imported frozen chickens, and the US retaliated with the “Chicken Tax.” A 25% import tariff on pickups. Colonel Sanders must have been proud. Toyota, Honda, and Datsun were tiny players in the market, selling cars that were born in the Japanese market for Japanese regulations, economics, and sensibilities. Small and fuel efficient. Unfortunately, Oil Shock 1 was born on October 15, 1973 with the OPEC oil embargo. Almost overnight, huge lines formed at gas stations and fuel prices skyrocketed. The issue here was more in short supply than long prices. In 1979 Oil Shock 2 was born with the Shah’s leaving and the start of the Iranian Revolution. Longer gas lines, higher prices. For six years nobody knew what to do about OPEC and uncertainties concerning the flow of gasoline to filling stations. Most thought we would return to “Pleasantville” normalcy. Product development cycles, to this point, had been in the 4-5 year range for the domestics. So, the domestic OEMs were looking down a long garden hose to see the future and then place their multi-billion dollar bets. Everybody knew back then that there was a practically infinite supply of oil. So, they hesitated. Meanwhile, a tidal wave of car buyers flowed to the small, fuel efficient car producers and Motown became, product-wise, flat footed. Chrysler started to teeter and hired Lee Iacocca from Ford in 1979. They were the most flatfooted of all and needed a Federal loan guarantee to avoid bankruptcy. They got it. In 1981 the Reagan administration enacted the Voluntary Restraint Act (VRA) where the Japanese OEMs would voluntarily limit exports to the US while the domestics retooled and became more competitive. This was a 2-Prong rescue. In the midst of this the K-car and minivans were born. But, haste makes waste. In 1981 JD Power published their first customer satisfaction index (CSI) for the auto industry.

At this point, if Bobby Fischer had been running General Motors, he’d have pushed over his king, conceded, and said, “checkmate in 27 years.”

Tommy, even with your pea-sized intellect, you could have won playing with this board. The Chicken Tax effectively prevented the Japanese OEMs from entering the pickup truck market, so this was an effective open prairie for the domestics to retreat to and harvest. The VRA was only focused on Japanese imports into the US. So, Hyundai (Korean) entered the market unfettered in 1986 (they set a first year sales launch record by selling 126,000 Excel models) and Kia (Korean) followed in 1994. Imports into the US were limited by the VRA and the Chicken Tax, so the Japanese built assembly plants in the US. Tom-boy, now this is a reading comprehension test - where did they build them? Why, of course, they built them in those largely non-union 22 Right to Work States! No UAW work rules, aged workforce, retirement benefits. But, they were smart; over time they paid their workers pretty much the same as the UAW. Sarah Palin’s 25-something Joe-Six-pack really didn’t have much to think about when UAW organizers spoke to him. “Hmm, do I risk losing my job and support the UAW, for nothing, or do I continue to work for this, hey, pretty good company?” No contest; no UAW. The Japanese transplants all-in costs were significantly lower than UAW shops, because they had modern, tax abated facilities without UAW work rules. They evolved faster and became ever-higher quality and more efficient. All the while, the domestics were trying to catch up; but, because of Oil Shock 1 paralysis, they were largely one product development cycle behind. The Japanese OEMs refined their fairly-small-car-but-getting-bigger product strategy in the 1980s and focused on quality – David Power was a hero. David Power developed charts that showed how good the Japanese cars were, and how bad the domestics were. He changed the rules of the game, but the domestics did not pay close enough attention. In the 1980s, while the Japanese were focused on better of the same, the domestics were producing worse, but different. Customers noticed and flocked to the Japanese cars, creating an undersupply situation that lasted for about 24 years. Fundamental economic theory prevailed, and these scarce commodities were priced up, resulting in high profits and high investment capital for the Japanese OEMs. Much of this became increasingly apparent to the domestic OEMs by early 1990. They were one product development cycle behind, producing inefficiently as measured by Jim Harbour, and running as fast as they could to compete with the Japanese on JD Power’s CSI quality scale. The Japanese owned the small car market, but that was irrelevant. The domestics couldn’t make money on small cars due to incredible competition, labor costs, and inefficient production. So, they fled to minivans, light trucks, and SUVs to make money much needed for quality improvements and product investment.

The boom of the post-recession 1990s was a loopy time in global business history. Internet companies grew huge market caps without P&Ls that made any sense at all. There was a pandemic of stupidity at that time that really had no boundaries. All business sectors were infected … including the auto companies. The internet had no boundaries; therefore “global” was the solution to all. Ford bought a slew of global luxury Marques, most of which have been sold. Daimler bought Chrysler and then sold it. GM bought a bunch of global tertiary players. Arnold Schwarzenegger bought one of GM’s first street-legal Hummers – a brand that appealed to our post-Desert-Storm sense of military pride and patriotism. Looking back, many businesses are now embarrassed about their mistakes. Many just plain old citizens look back, too, and wonder how we could all have been so stupid. But, we survived.

Gas prices crested over $3 a gallon during 2005’s Katrina, yet market share of the big stuff continued to grow. Hey, this is America, the big country with a Texan President – we drive big cars and big trucks! Well, yeah, until we can’t afford them anymore.

Tom-boy, you prattle on and on about how bad domestic product is and blame this for the current predicament that they are in. Well, you are really talking about the stuff that was produced 20 years ago. That’s when the checkmate really occurred. Wake up and read what’s happening now, stupid. Product quality is not really a problem today. In 2007 Ford’s score in JD Power’s CSI was 868; the same as Toyota’s. Buick’s CSI was 918 (higher is better.) JD Power’s 2008 “Initial Quality Survey” (IQS) gives the edge to Toyota; for every 100 cars produced, they have 104 quality problems - a tad more than one per vehicle. For Ford the number is 112, and for Buick it is 118. Both of these are still just a tad over one per vehicle produced. Tommy, if you are right and folks don't want the products that the domestics are building, then why of the top 20 models sold through October do the domestics produce half of those that have increasing sales? Besides being stupid, you are incompetent.

What happened and why are the domestics teetering on bankruptcy in 2008? It would be wrong to exonerate them from all past sins. There are plenty of screw-ups to be tagged on lots of different companies. Toyota is a brilliant company. They just built a pick-up truck plant in Texas and are struggling to sell its production. Nissan produces some of the most beautiful cars in the world. They build their new full-sized Titan pickup in the US and are struggling with it. Why did Honda Civic sales go down by 22% in October? Circuit City, the darling of Wall Street a few years back, just declared bankruptcy. LG, Sharp, and Chungwa recently agreed to pay a penalty of $585 million for price fixing in the LCD market. Hey Tommy, China spends a lot more with lobbyists than the entire motor vehicle industry – and, by the way, what’s all this about them hacking into Obama’s computer systems? Screw-ups and mistakes happen and are part of life – it’s why they invented the word “forgive.”

So, besides normal mistakes, what happened? It is really quite simple. People buy motor vehicles from three sources of “funding.” (1) They use home equity loans to borrow and buy a car. Well, the subprime-induced housing debacle screwed this one up – we allocated $700,000,000,000 to help out the financial institutions that got us in this ditch. (2) They talk to family, friends, and spouses, look at their savings, and make a decision that they can afford a new vehicle. Nope. Wall Street’s economic crisis has wiped out about a third or more of their savings and the media has them scared out of their minds about losing their jobs. “Cut back!” is the media mantra today. They can’t “afford” to buy. We allocated $700,000,000,000 to help out the financial institutions that got us in this ditch. (3) They feel lucky and try to get a loan. Nah, even Paulson admitted that this part of the financing market has been practically nuked. We allocated $700,000,000,000 to help out the financial institutions that got us in this ditch. So, Tommy, you stupid moron, it’s all about cash flow that the boys downtown really screwed up. It’s not about bad product that customers don’t want. It’s not about quality that was fixed years ago. It’s about somebody else’s greed.

All the information used to write this blog came from free access web sites that do not require a subscription, or proprietary Carlisle & Company sources.

Sunday, November 16, 2008

What’s Going to Happen In 2009?

We all need to think some more about 2009 – things are changing at a fairly rapid pace. We have two choices: (1) assume chaos and cut to the bone, or (2) try to divine the logic of what’s happening and plan accordingly. The global consumer is roaring like a lion with his/her response to what has happened with our economic meltdown. It is quite logical. Responses to the current situation should also be quite logical. Somehow, logic has not been in abundance in Washington. We are thinking of swapping an auto industry bailout for a free trade agreement with Columbia. We’ve ushered in a plus-$150 billion bailout of AIG with its relative handful of middle class jobs (you know, the folks who clean the executive bathrooms for their top money men and women). Yet, few take issue with the plus-3 million jobs in the motor vehicle industry getting vaporized by the toxic waste left by Wall Street greed.

Planning for an uncertain future must start with the absolute basics of what we know. The NY Times has abundantly reported and charted rising unemployment and job loss rates. People are frightened about their ability to economically survive and, as a direct result, are significantly cutting back on spending. Home prices have fallen off the cliff and left little positive equity for funding large purchases. We are more than one year away from any improvement here, so folks are cutting back on buying big stuff. The plunging Dow has become a graphic display of personal wealth. 401K plans and retirement savings are down, for many (if you are lucky) by a third. So, folks are uncertain about the future and are thinking of how they will replace their lost wealth. They are troubled, scared, and uncertain. So, they cut back. Those with the courage to spend get their hands slapped when financing their purchase – many have high, but flunking, credit ratings. Congress allocated $700 billion for a bailout, but nothing good seems to be happening. Gas prices are plunging because nobody’s driving their car – a mixed message for this industry, if ever there was one. Goods consumption is down, so fewer “goods” need to be moved. Therefore, the trucking industry is getting whacked both by intermodal freight and simple raw forces of nature. The Fed is now worried about “deflation” – we can see it in falling grain prices … and this is the segment we felt good about earlier this year. This can be pretty depressing. Instead, I call all this “data.”

So, we can either become paralyzed while soaking up more bad news, or we can trust Barack to figure a way out of this box and be logical. Best bet is to trust Barack. Logically, we can’t fix the long range problems with our economy until we fix the most pressing short range issues. As a fresh new president, what would you rather do first, (1) create a million new jobs out of the ether, or (2) save a million jobs from getting axed? Barack’s a smart guy and will pick door number 2. So, logically, he will choose to rescue the motor vehicle industry, because there are at least a million jobs on a quick-step march to the guillotine. How will he do it? Barack’s a smart guy and knows he needs a genius to explain why spending $150 billion on AIG makes sense. The big takeaway here is that while we are spending that $150 billion, the Dow’s slipping and jobs are being shed at a record pace. So, he will figure out that he needs to do something different. If logic prevails, we are likely to see a 2-pronged bailout. Prong 1: do something that promotes buying new vehicles right now – this will create a group of “hot-ter” products; and Prong 2: separately, provide unfettered loans ($25 billion or so) to the domestics, so that they can stay in business for the next year or so. Based on pure logic, we expect that sales of domestically assembled motor vehicles will rebound sometime in the second quarter of 2009 (compared to the atrocious second half 2008 running rate.) The domestics will receive loan guarantees, and Cerberus will turn over Chrysler to the “right” suitor.

What does all this mean for automotive service parts sales? For the “hot-er” segments, (second quarter volume pick up) accessories will rebound (even SUVs will sell because of lower gas prices). For those who are not bailed out, owners will continue to delay vehicle purchases and will look to repair and maintain what they’ve got. (If the dollar continues to strengthen, small car foreign OEMs might weather 2009 without much storm damage.) This should boost M&R sales for all OEMs across all segments in 2009. Troubled dealers continue to pressure fixed operations to carry more and more of the dealer fixed costs. So, typical dealers will put more pressure on increasing labor rates, labor content, parts margins, and shop fees. Unless the OEMs do something about this, much of the 2009 surge will go to the independents as vehicle owners increasingly confirm the busted notion that dealers are the high cost spread. Since the Prong 1 stimulus might not be in the form of a rebate or incentive, it might not have as negative an impact on residual values as what goes on in the current rebate war. So, fewer totals and a positive signal to collision sales. Adding fuel to this growth will be cheap gas, causing more miles driven, leading to more crashes. The top three areas to stress in 2009? Accessories, kinder and simpler service retention, and collision.

What does it mean for Ag? Logically, the US needs stable-to-increasing agriculture exports to hold on to any semblance of a balance of trade. So, don’t expect to see less assistance for ethanol production and other farm subsidies… in fact, you might see more as we march more strongly to energy independence. Key futures of commodity prices have fallen to 2007 levels, with wheat back-sliding the most. Corn harvests will be down 6% in ’08, but soybean harvests will be up 15%. The dollar has strengthened mightily – this is bad for exporting both food and tractors. Although tractor sales are up 4.1% in 2008, Ag will not be able to hold on to 2008 levels of whole goods growth; but, it won’t be all that bad. Tight credit will further dampen whole goods sales, while M&R parts will do OK as farmers squeeze more life out of what they’ve got … and use it to harvest 2008’s bumper crops. The biggest whole goods hurt will be in the small stuff – lawn & garden and mid-sized stuff for the smaller lawn and grounds care contractors. Since Ag has much higher service retention than auto, the parts sales for this segment will look a lot better than the sales for incidental items. What to stress in 2009? How to reduce cost of ownership through repair and maintenance – across all segments.

What does this mean for construction? Logically, good and bad. The big stuff used for “WPA” roads, bridges, and airport type infrastructure investments will do well, both domestically and export. But, this will take a couple of quarters to get any sort of momentum. This is due to China’s massive half-trillion-dollar economic stimulus, as well as likely US and other global get-to-work job rescue programs. In 2009 US exports will not be boosted by an incredibly cheap dollar – so, pricing will be an issue. Outside this, most analysts see capital spending drying up. The small stuff for residential construction will get some benefit from the smaller infrastructure rebuilding projects, but largely will have to wait another year in the ER for trauma care. I suspect parts sales will follow whole goods sales, because there’s little need to squeeze more life out of equipment that’s not being used. 2009 pressure points? Mining, supporting the big stuff, seamless exports, and for the second tier players, integrating operations and assets to get much of the waste out of the value-chain.

What does this mean for heavy trucks? First off, somebody has to figure out why low sulfur diesel, that was supposed to cost a nickel a gallon, ended up costing a buck a gallon. This still is pushing freight to intermodal. The good news is that this trend will abate somewhat by falling diesel fuel prices. Total freight movements will be down as we consume less. Port of call networks will be rationalized as container rates fall – this will hurt intermodal, as inland stem distances fall. Diesel engine sales to the domestic super duty market will continue to shrink in 2009. And, truck exports will be hurt by the stronger dollar. If that complexity is not enough, 2010 emission regulations should act to pull ahead truck sales like it did in 2006/7 (though few in the industry are holding their breath on this one – expecting a much smaller spike). The good news is that engine technology to meet 2010 standards could be a differentiator. Chaos. But, this segment is used to this type of cyclicality and will survive. 2009 focus? Cutting back in capacity, SG, and jobs for 2009, but still planting seeds for 2010 growth.

What does this mean for cycles and recreational vehicles?
2009 will be a very tough year. You need to work on lowering fixed costs.

Monday, November 10, 2008

Hey, Joe the Plumber, What’s the Correct Role of Parts Pricing?

To understand pricing, you really need to understand Joe the Plumber. He was my favorite. Joe the Plumber questioned Barrack Obama about his taxes going up and claimed that he’s considering buying another plumbing business. Well, it was captured on TV, and next thing you know he’s travelling with John McCain, got a press agent, and signing contracts. Meanwhile, we find that he hasn’t paid his current taxes, he’s not a licensed plumber, ain’t’ going to buy nothing, was not registered to vote, and determined that he’d pay less taxes under an Obama administration. Joe’s no dummy – he’s just following his nose in the wrong direction. In terms of pricing, many in the industry are taking Joe’s lead and letting their instincts lead them in the wrong direction. We have loads of evidence that helps us become more “Joe-like.” The Conference Board just published a depressing graph in the NY Times, showing customer confidence at its lowest level in at least 40 years. The GDP made an unprecedented decline last quarter. Fox News and MSNBC may not agree on who’s the worst person in the world (Keith seems to nominate Bill O’Reilly most nights) but do agree on a bleak near term.

Joe the Plumber, if he were working for an OEM, would take all this in, get a press agent, buy a new pair of jeans, and declare that we shouldn’t raise dealer net parts prices for awhile. He’d be dead wrong. The NASPC Parts Manager Satisfaction Survey was just published – over 11,000 dealers participated. (Call Harry Hollenberg on this – he’s the expert – 978-985-6659.) We launched the 2008 survey during the post-Lehman Brothers economic collapse - the worst possible time in the world. It is interesting to note that average dealer satisfaction with the OEM actually rose from the halcyon days of 2007 to the funk we are now in. Average dealer purchase loyalty to the OEMs rose by 1.7% during that same period. RIM and technical telephone support were bigger issues than pricing, and satisfaction with OEM wholesale support actually rose.

The problem isn’t with wholesale parts prices. As I said last week, the problem is with end-customer perceptions of dealer retail prices vs. what they can get from Joe the Mechanic down the street. Have you ever purchased a mattress? It’s just like buying repair or maintenance services. Customers walk in the door with very high brand awareness and functional knowledge of what they want to buy (e.g., Joe the Plumber knows that his bed has a mattress that helps him sleep.) But, when it comes down to buying, there is little to compare to when gauging the deal. Sealy, Serta, and other mattress companies proliferate model designations almost to a store level, so you can’t benchmark product derivations and prices. Think of a mattress as being just like 98% of all your parts. There really are no benchmarks to gauge the reasonableness of the retail prices of 98% of the parts on a repair order. Sealy mattress “A” costs $400 at Sleepys with a $50 delivery and disposal charge vs. Serta mattress “B” costing $450 at Mattress Discounters with free delivery and disposal. They might be identical mattresses, but you’d never know. Joe the Plumber makes his choice not based on “parts cost,” but on which brand and retailer made him feel better about the purchase. Something he can sink his teeth into. More importantly, Serta probably won’t sell more mattresses by reducing their wholesale prices because the acceptable band of retail price comparability won’t be budged much either way they go in wholesale pricing.

OK, now let’s talk about parts pricing. For this exercise we need to upgrade Joe’s IQ – move it from 85 or so to 180: call him Einstein the Plumber. Einstein has access to all the facts. He looks at an “average” repair order (RO) for independent repair facilities (IRF) and normalizes it to $100 so he can easily compare costs. He does the same with average dealer repair orders. First off, Einstein immediately sees that the total costs on the ROs are nearly identical. Hmmm he says. He compares the parts charges: IRF’s at $43.20 and dealers at $37.00. Einstein scratches his head because even with his prodigious mental powers he can’t compare the actual parts and parts values from one RO to another. He looks at the shop supplies and miscellaneous charges: IRFs at $20.80 and dealers at $17.30. He has no idea what these cover – maybe the IRFs have to pay more for engine oil recycling. No conclusion. Einstein then looks at the labor rates: IRFs at $70 and hour and dealers at $85. Eighty five dollars an hour? Hey, that’s a lot of money! Confirmation comes when he does the math and IRFs have $36 worth of labor on the RO and dealers have $45.70. This is an easy exercise for Einstein the Plumber, because he has something he can sink his teeth into. He concludes that dealers are more expensive. They are more expensive on the things that a common man, Joe-whoever, can identify with.

Pricing experts talk a lot about pricing elasticities. Simple concept; with all things being equal, volumes are relatively “elastic” when they react to price differences. Volume is relatively “inelastic” when there is limited relationship between prices and volumes Pricing Academics and pricing software salespersons urge us to gauge the relative elasticity of a part and price accordingly. Sometimes I feel sorry for them – they’ve got it backwards. A better strategy is to: (1) directly manage the pricing elasticities, (2) consistently price those parts you are managing to be inelastic, and (3) get a tattoo printed on your wrist to remind you that the retail pricing problem is mostly a perception problem. Directly managing inelasticities means making all things not equal. If the mattress folks can prevent us from cross-shopping mattresses, why can’t we prevent our customers from cross-shopping ROs? What does this mean? It means working with dealers to educate them how to prepare a better RO and characterize their labor charges. Serta doesn’t break out the cost of the springs from the fabric from the labor to put them together – why should we? It also means educating vehicle owners on what they get from that hour of service labor – it’s the parts equivalent of the Verizon commercial. It means educating service advisors in the entire lifecycle of customer care and education. It means fixing problems before customers walk away less than totally satisfied. It means getting dealers involved and understanding how much more money they can make. In short, it means differentiating your parts and service not so much with an eye on Madison Avenue, but with an eye on Joe and Janet the Plumbers and understanding why they assume dealers are the high cost spread. Consistently pricing parts is all about improving your yields in areas where there are opportunities (Paul Gurizzian is the world’s expert in this – call him at 248-767-9277.) It’s also about not doing stupid things, like pricing oil filters at twice what Wal-Mart fetches. Now for that tattoo … my daughter’s friends know all the best places in Massachusetts ... please don’t call her.

There are three reasons – Catch-22s – why most OEMs can’t implement such a strategy: (1) they would have to fund it with increased parts prices, and they cannot effectively manage more than single-order-effect investments strategies (e.g., this is the “Dilbert Effect” where the additional margin immediately goes to the corporate coffers with no portion to strategy funding – so, to Dilbert it looks just like any other price increase); (2) they would have to work with dealers to change the way they do business and not take a one-size-fits-all strategy … and this is too difficult; and (3) they would have to do something different and stand alone … scary.

Monday, November 3, 2008

So, What Do We Need To Fix?

Customers are changing their service locations – well, that’s nothing new. What’s troubling is that they might be switching out faster than we anticipated. A certain amount of this is caused by lower industry replacement sales, causing an older average fleet that has a higher tendency for non-dealer service. But that’s just making ourselves feel good about a bad thing. The reality is that customers are more cost conscious than ever before and the pre-conception that the dealer is the high cost alternative has a lot of momentum.

Checking this out is a simple from/to matrix operation. AutoZone’s sales and profits are up. My theory is that Zone is the “to.” So, maybe customers are walking, and we pretty much know why they are walking. Let’s check the facts. We found from prior NASPC surveys that for a normalized $100 repair order (RO), independent repair facilities (IRFs) have higher parts cost content than dealers. When we examined comparable survey ROs from IRFs and dealers, we found the costs to be within spitting distance of each other (the difference was not statistically significant in our sample). These costs are pretty easy to detect on ROs. The big differences between dealers and IRFs are with labor rates and charges. Dealers generally have higher labor rates than IRFs, and dealer ROs generally have proportionally higher labor content. This makes sense, considering dealer/OEM technician training and diagnostics infrastructure. Dealers have an edge in efficiency; we found that dealers are generally less expensive for all forms of maintenance. The problem is with repair order “optics.” As I said, total costs for a market basket of repair orders shows comparability, yet IRFs seem to have lower published labor rates (20% lower) and make more money on parts. Dealers have signs in the service write-up area broadcasting typical $80-$100 labor rates. Customer satisfaction with labor rates is dead last on the list of all possible sources of friction. We’ve known about this for years, and mostly have done nothing about it. Let me reduce this down to simple common sense. You look at a repair order and see a charge for parts that you have no idea how to value, and you are confused; no basis for comparison. You look at the labor rate and see that it is higher than you might make per hour; higher than what you pay your plumber. Here, you do have a basis for comparison and don’t feel so good. You conclude, wrongly, that dealers are the high cost spread and decide to look for lower cost solutions … what about that shop down the street that charges only $60 an hour? Times are tough, so you decide to “cut back” and not go to your dealer. And, you feel good about making this bad choice. This is a dealer issue. So, how do today’s customers feel about this? Those same folks who have lost 20% of the value of their 401Ks? How about the ones fearing eminent job loss? The ones paying yo-yo gas prices? The ones upside-down on their home equity? The ones now shopping at Wal-Mart instead of Macys? They feel like not going to dealers for service. So, what can we do about this? Funnel our marketing allowances, advertising spend, and some portion of our terms and conditions money (don’t laugh at this – rewarding dealers with a stock order discount when all the choices are daily could be seen as humorous also) into consumer awareness advertising. Educate consumers about what they get from dealers and the facts about what they spend. Of course, this would involve our dealers, which makes it a non-starter for many OEMs.